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Tata Capital > Blog > Personal Use Loan > Does Prepayment of Personal Loan Affect Your Credit Score?

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Does Prepayment of Personal Loan Affect Your Credit Score?

Does Prepayment of Personal Loan Affect Your Credit Score?

Personal loans are undoubtedly one of the best instruments for resolving financial constraints and achieving major milestones in life. Since these loans don’t need collateral from borrowers, they are naturally quite popular.

At times, borrowers prefer to pre-pay the loan ahead of time and get the burden off their shoulders. Many also do this if they are planning to take another loan and don’t want to service two loans at a time. Are you wondering if prepayment is a viable option for you? Will it affect your credit score? If yes, how?

Let us take a look at how pre-paying your loan impacts your credit score.

Understanding Factors Affecting Credit Score (Beyond Prepayment)

Credit scores depend on multiple credit score factors, and understanding them can help you build long-term financial stability.

  1. Payment history

A payment history of timely EMIs and card payments can strongly improve your score. Likewise, missing payments can hurt your score.

  1. Credit utilisation

Using only part of your available credit helps maintain a good credit utilisation ratio.

  1. Credit mix

Maintaining a healthy credit mix with secured and unsecured loans can be helpful for your score.

  1. Hard inquiries

Making multiple loan or card applications can lead to hard inquiries that lower your score temporarily.

  1. Length of credit history

The length of credit history demonstrates your financial responsibility.

  1. Debt-to-income ratio

A lower ratio shows that you can manage your debt properly.

Does Pre-Closure of Personal Loan Hurt Your Credit Score?

There is generally no negative effect of prepayment on CIBIL score.

Making part payments to reduce your outstanding balance usually doesn’t affect your credit score. A full prepayment, on the other hand, can improve your credit health. This pre-closure can lower your overall debt and show your disciplined repayment behaviour, which is why lending institutions view this positively. 

As long as the loan is reported as “closed” with timely EMIs, there is no real concern of personal loan preclosure hurt credit score. In most cases, there is no negative impact prepayment credit score issue for borrowers.

Factors to Consider Before Personal Loan Prepayment

Debt-to-income ratio

Personal loan pre-payment can reduce your debt-to-income (DTI) ratio since your debt obligations will reduce. This is advantageous for you if you are planning to take on another loan after prepaying your current one. The lower your DTI, the higher are your loan approval chances. Thus, if you’d applied for the loan for emergency funds, and are now able to re-pay, you can consider pre-payment. 

Savings

While repaying your loan early can relieve you of the loan burden, exhausting your savings to do this can prove risky. It will definitely affect your ability to tackle any unforeseen financial emergencies. However, if you have ample savings with left even after pre-payment, you can think about it. But, if your savings are slim, personal loan repayment before the due date is not advisable.

How Pre-Closure of Personal Loan Can Positively Impact Your Credit Score

Pre-closing a personal loan can boost your credit score, if you go about it strategically.

One of the key personal loan pre-closure benefits is immediate debt reduction, which improves your credit utilisation. In turn, it may raise your score. 

Early repayment also demonstrates that you have strong financial discipline, explaining how early payment helps credit score over time. Since you clear the loan before the full tenure, lending institutions will see you as a low-risk borrower. In the future, this can be helpful in securing loans at better rates and terms.

If you maintain other active credit accounts, you can still improve credit score by prepaying loan without affecting your credit mix.

Impact of prepayment on credit score

If making timely payments towards your loan spells good news for your credit score, then the same logic should apply to paying your loan off early, right? Unfortunately, it does not work that way.

Paying off a loan is much different from clearing the dues of credit cards and paying EMIs. When you clear off a loan completely, your credit report indicates a closed account. However, when calculating your credit score, credit rating bureaus take your open accounts into consideration.

Effective management of the finances of the open accounts has a more significant impact on credit scores than the ones closed early. This is because open accounts are indicative of your present and past debt history. While timely and regular payments on closed loans form a crucial part of your credit history, the personal loan impact on credit score is not too significant. It is worth remembering that this logic does not apply to credit card repayments. An active credit card account is always considered an open account. Thus, even when the balance is full and untouched, your credit line stays intact.

Conclusion

If you do have the funds to pre-pay your loan, it is something you can consider. Whether you decide on paying off your loan early or not, it is vital to choose an established lender like Tata Capital. Come to us for attractive 

personal loan interest rates, flexible terms, and minimal personal loan documentation.

What’s holding you back? Reach out to us right away and enjoy reliable lending solutions at Tata Capital!

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FAQs

Does prepayment affect credit score directly?

To answer, “does prepayment affect credit score?”, prepayment does not directly harm your credit score. Closing a loan early mainly reduces your debt, which is positive. However, it won’t instantly boost your score. It has to be combined with other good credit habits like timely payments and low credit utilisation.

How does personal loan pre-closure impact my credit score?

The effect of prepayment on CIBIL score includes an improvement in your credit health. Prepayment helps by lowering overall debt and showing responsible repayment behaviour. Prepayment can shorten your payment history, but it has an overall positive impact in the long run.

Can paying off a personal loan early lower my credit score?

Paying off a personal loan early usually doesn’t lower your credit score. A possible negative impact prepayment credit score could be a shorter length of credit history. Overall, clearing debt early is seen as responsible behaviour and often helps improve your creditworthiness.

What are the benefits of personal loan prepayment on my credit history?

Prepaying a loan lowers your total debt and reduces credit utilisation, which helps your credit profile. It also demonstrates good financial discipline, making you appear reliable to lenders. Over time, this responsible behaviour can positively affect future credit approvals and loan terms.

Is it advisable to prepay my personal loan if I have other debts?

It depends on the interest rates of your other debts. It is ideal to clear off your high-interest loans first, for maximum benefit. If your personal loan has a lower interest, focus on tackling other debts and building an emergency fund in the meantime.

Do personal loan prepayment charges influence my credit score?

The answer to “does prepayment affect credit score?” when it comes to personal loans is that there isn’t a direct influence. Some personal loan prepayment charges may be excessive, which can cause you to run out of savings, countering the advantage of the early repayment. 

How does closing a loan account affect my credit report length?

Closing a loan account can slightly shorten the length of credit history, especially if it was an old account. A shorter credit history is one of the minor credit score factors. However, the benefit of reduced debt and positive payment history usually outweighs the negatives.

Should I use my emergency savings to prepay a personal loan?

It’s generally not advisable to use up your emergency savings for loan prepayment. Maintaining an emergency fund is important, in cases of unforeseen expenses. Personal loan pre-closure benefits only apply if your personal loan carries very high interest, and you have savings for financial emergencies.

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